Lloyds (LSE: LLOY) shares are quietly returning billions to investors. In 2025 alone, the bank delivered up to £3.9bn in dividends and buybacks — equal to around 6% of its market value — while also increasing total capital returns and steadily growing its dividend.
Yet, despite rising payouts, a 15% dividend increase this year, and an 80% rise since 2021, the valuation still looks surprisingly low.
So why isn’t the market rewarding Lloyds shares for this growing stream of shareholder returns?
Low valuation
One reason Lloyds shares still look relatively cheap is that investors are unsure how much of the recent strength will last.
Higher interest rates have helped boost earnings across the banking sector in recent years, but there is still a question over whether that support will continue to the same extent in future years.
At the same time, UK banks often trade on lower valuations than other parts of the stock market because investors tend to wait for long periods of consistent performance before re-rating them higher.
So, even though the latest results look strong, the market appears to be taking a ‘wait and see’ approach rather than fully pricing in the improvement.
Re-rating story
However, there are signs that the improvement in performance may be more durable than the market is currently pricing in.
One of the clearest shifts is on costs. The group expects its cost-to-income ratio to fall below 50% in 2026, reflecting years of restructuring, a simpler operating model, and continued savings from digital banking.
At the same time, earnings are becoming less dependent on interest rates alone. Management highlighted growth in fee-based income alongside lending activity, suggesting a more balanced revenue mix than in previous cycles.
Technology is also beginning to play a more meaningful role. The bank generated around £50m of benefit from AI initiatives in 2025 and expects this to rise to more than £100m in 2026, as use cases expand into higher-value areas. While still early, management sees this as a growing driver of both revenue and efficiency.
Taken together, these factors point to a business that may be building more sustainable earnings power than the current valuation implies.
What could go wrong?
Despite the improving outlook, Lloyds remains heavily exposed to the UK economy. If household spending or business confidence weakens, that would quickly feed through into lending growth and overall profitability.
There’s also a risk from interest rates. Recent earnings have been helped by higher rates, but as they gradually come down, that boost to profits is likely to reduce.
More broadly, competition in UK banking remains intense, with digital-first rivals continuing to target the same mortgage, savings, and current account markets. That could make it harder to sustain strong margins over time.
On balance, I think the shares are worth keeping on the radar. I don’t currently own them given my existing exposure to UK banks, but the combination of rising shareholder returns, improving efficiency, and stronger revenue diversification makes this a name to consider.
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Andrew Mackie does not hold any positions in the companies mentioned.
